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Veterinary Forum December 2009 (Vol 26, No 12)

What's the future of the veterinary pharmacy?

by Lowell Ackerman,
DVM,
DACVD,
MBA,
MPA

Veterinary medicine is not recession proof,1 but it is resilient and has fared better than many other industries that rely on the public's discretionary income. However, the industry is vulnerable in a few key areas, including the pharmacy.

The pharmacy has long been a solid profit center for veterinary practices, and according to AAHA's Financial & Productivity Pulsepoints, Fifth Edition,pharmacy income averages 18.9% of total hospital income, with food sales representing an additional 4.9%.2 Add to that potential over-the-counter retail sales (including parasiticides, shampoos, flea combs) that AAHA reports as an additional 6.1% of total hospital income, and product sales account for more than 25% of hospital revenue.

How secure is your pharmacy revenue stream in the era of Internet pharmacies, inexpensive human generics, big box retailers and other companies competing with veterinarians for pet-owner dollars? Clients have more options than before when choosing medications for their pets, and it is time for veterinarians to consider how to best use their pharmacies and compete in a crowded marketplace.

Do we need to change?

For many decades, veterinarians have had a relative monopoly on the sale of prescription pet medications, and this has been an enduring boon for many practices. However, while many clinics have priced pet food relatively competitively after realizing that pet owners would likely comparison shop, most practices continue to price their prescription drugs the same way for years.

Veterinarians may worry about Internet pharmacies and advertising that entices some clients to ask for prescriptions and shop elsewhere, but this is only the beginning. We have not yet reached the "tipping point" at which clients will routinely look elsewhere for pet medications. As clients become aware of alternative channels for acquiring veterinary medications, they will realize that Internet and big box retailers now sell some of the most popular pet medications and that veterinarians frequently dispense human generic drugs that are much less expensive — and, in some cases, free — elsewhere.

When a client brings a pet in for an examination, he or she is prepared to pay professional fees for veterinary expertise in medical care, diagnostic testing and treatment recommendations. After all, veterinarians deserve proper compensation for the high level of skill they offer.

However, after the veterinarian recommends a treatment, the professional part of the visit concludes, and the client is free to purchase the recommended products from any business that offers the best combination of price and convenience. Most clients will pay a slight premium to purchase the medication in the veterinary office, but medication is often considered a commodity and not something to which professional fees should be attached. For example, is the cephalexin that you dispense superior to the cephalexin available at a retail pharmacy? Is the flea control product that you sell different than the identical product available at retail outlets or on the Internet?

Clients will not begrudge spending more at a veterinary office than at a retail outlet for a similar product — within reason. Clients may perceive that it is more convenient to purchase a product at the veterinarian's office, but when this convenience is coupled with counseling from staff on the product's proper use, the client may recognize the added value to the purchase.

However, if there is a large discrepancy between a practice's prices and a retailer's, owners may be concerned that prices for services at the practice might be inflated as well. This is not the type of message a practice wants to convey, considering that veterinary services are a relative bargain for pet owners compared with human medicine.

Human generic medications

Human generic medications are tested for equivalency against branded human medications. Most of the human generics that veterinarians stock, which are not FDA-approved for use in animals, may come in inconvenient dose sizes for animals and may have directions and cautions that are inappropriate for animals. From a business standpoint, these products are the same or similar to those sold by pharmacies, department stores and other retailers, often for considerably less cost. Retailers are locked in a bitter battle for customers and, in some instances, have reduced the price of many human generic drugs to a few dollars for a month's supply. Some retailers even provide these products — including prescriptions for pets — at no cost to the consumer.

Realistically, there are only a few options for dispensing human generics, none of which is very profitable. You may be able to sell the product for less than the branded medications that you carry, but there is no way that you can sell them as inexpensively as low-price retailers and still make a profit. What do you tell clients who ask about the difference between the human generic that you offer and the less expensive human generics available elsewhere? Even if veterinary practices drop dispensing charges, it is still impossible to offer human generics at a competitive price without losing money.

The other option is to continue selling human generics and hope that clients do not notice that the same products are available elsewhere at significantly lower prices, despite the millions of dollars that retailers spend to promote their bargains. Pet owners are being conditioned to expect that human generics are the treatments of choice for many animal ailments — likely an unintended endorsement by the veterinarians dispensing them.

This does not mean that human generics do not have value. If the goal is to deliver medications to owners at fair and competitive prices and you believe that administration of a human generic is in a patient's best interest, then the sensible solution seems to be to write prescriptions for these products and allow owners to find the best bargain.

When the profitability of selling human generics is analyzed, the drugs only remain profitable at current veterinary pricing as long as clients are unaware of the alternatives. This is not a sustainable business model. In addition, profits tend to be marginal at best when markups are applied to inexpensive medications. If a human generic costs you a few pennies each and you triple that to arrive at a retail price, you still have a very meager return for something the client could have purchased elsewhere for less money.

From a business perspective, it makes the most sense to stock veterinary-labeled products for sale and price them appropriately (more on that later). These veterinary-labeled products are FDA-approved, tested in animals for safety and efficacy, come in formulations that are convenient for the species you are treating and are manufactured by companies that support the veterinary industry and stand behind their products if there are problems or adverse events. This should be a compelling argument. After all, what have human generics companies done for you lately?

What about internet pharmacies?

Most veterinary practices are concerned about Internet pharmacies, but these companies are only exploiting the sometimes unrealistic drug pricing models used by some veterinarians. Veterinarians may be surprised to learn that most veterinary pharmaceutical manufacturers do not sell products directly to Internet pharmacies.

Often, non-veterinary Internet pharmacies purchase products from veterinarians who are often referred to as diverters and who purchase the products from manufacturers or distributors. New pharmacy licensing requirements require wholesale drug distributors that know or suspect that prescription drugs are being diverted to report their suspicions to the licensing agency,3 but for now, this practice still appears to be commonplace as evidenced by ongoing sales of these products through non-veterinary channels.

It is interesting that even after diverters are paid a commission for buying these products for Internet pharmacies, the pharmacies are still able to sell the products for less than veterinarians who price according to standard markups. This is because Internet pharmacies sell commodities based on a retail competitive pricing model, while some veterinarians continue to try to price products as if they were professional services. If veterinarians adopted a more retail-friendly pricing model, Internet pharmacies would likely cease to be much of a threat because they compete based mostly on price and, to a much lesser extent, on convenience. Internet pharmacies also have inherent expenses associated with shipping and handling and paying commissions to acquire diverted products.

Veterinarians have yet to heed the warnings, and Internet pharmacies have done quite well at the expense of veterinary practices, even in a tough economy.

What are the alternatives?

To operate a pharmacy as an efficient profit center, veterinarians need to manage inventory and price products appropriately. There are very real costs associated with inventory, such as the direct cost of acquisition, which is the price paid for the medication itself, and indirect costs associated with ordering and stocking products. The indirect costs can constitute 20% to 45% of the acquisition price, depending on how efficiently the pharmacy is managed.

The most challenging issues regarding pharmacy vulnerability involve pricing models, which can be complicated by the tendency to pay associates professional commissions on pharmaceutical sales. The three basic pricing models used in veterinary practices today are markup, margin and community pricing.

Markups are the most common. It is not unusual for veterinary hospitals to use markups of 100% to 200% to arrive at a retail price. This is the result of doubling or tripling the acquisition cost of medications and adding a dispensing fee. The magnitude of markup is extreme by retail standards, and paying a professional commission on pharmaceutical sales only compounds the problem of trying to close the gap between veterinary prices and those of competitors.

Markups have another unfortunate consequence: they tend to amplify the costs of expensive medications or treatments intended for large dogs and minimize the costs of inexpensive medications or treatments intended for small dogs or cats.

For example, if a practice doubles the price of a $0.10 tablet, it has $0.20 of revenue per tablet and $0.10 of direct cost. If the practice doubles the price of a $10 tablet, it has $20 of revenue per tablet and $10 of direct cost. Does this make any sense? Consider the administration of an injectable antibiotic that costs $1/lb of body weight at a clinic that typically doubles costs to arrive at a retail price. If the injectable is used in a 10-lb cat and the practice charges $20, the drug cost is $10, and $10 is left to cover all indirect costs and commissions and to provide a profit. The client would have likely been prepared to pay much more for the convenience of not having to pill his or her cat.

However, if the practice charges $200 to treat a 100-lb dog with the same injectable, the drug cost is $100, and $100 is left to cover all indirect costs and commissions and to provide a profit. The client would not likely be as happy as the cat owner. After the cost of the drug was covered, did the practice need to charge 10 times as much for injecting the dog, compared with the cat? The cat owner obviously received a much better deal.

For practices that see the inequality in the markup model, margin or cost-plus models are good alternatives. Veterinarians already use this premise on a simple level when selling pet food. They implicitly realize that the cost of a bag of pet food cannot be doubled or tripled without a lot of tough questions from pet owners. Often, clinics apply a unit price to each item rather than a markup formula or use a much lower markup than that used for pharmaceuticals. In addition, practices rarely pay professional commissions on the sale of pet foods because the prices would not be kept competitive.

A similar approach can be taken with pharmaceuticals, such as tablets, capsules, liquids, shampoos and injectables. The approach can be profitable for the practice and fair to clients, regardless of the size of their pets or the cost of the medications. This approach involves adding a margin or base amount to products or services that does not vary with the cost of the drug or the size of the animal.

Margin pricing involves taking the actual unit cost of the drug and adding an acceptable amount to cover indirect inventory costs of ordering, storage and loss. This indirect inventory cost can be expressed either as a fixed amount or as a percentage of actual product cost. At this point, there is full cost recovery of all direct and indirect costs, but no profit. A unit or margin charge is then added and represents what the practice wants to earn for each unit dispensed or administered. This allows the practice to make a standard margin on every product sold while covering acquisition and inventory costs.

With this method, there is no penalty for a pet that requires a more expensive medication. The practice makes relatively more on less expensive medications, which are less likely to be price-shopped, and relatively less on expensive medications, but with the same net profit regardless of the product. This allows veterinarians to select the product that would be most appropriate for the pet without worrying about loss of profitability for the practice. It is possible to pay commission to associates on the basis of margins, but only on the margin amount itself and not the full retail price, since all but the margin represents expense, not profit.

Community pricing is a way of establishing a selling price on the basis of what others are charging. A practice might set the community price based on the pricing used by other veterinary hospitals in the area, retail prices, Internet pharmacies or other outlets. Community pricing ensures that you will not be readily undersold; however, unless costs are determined, you may still be stocking and dispensing medications that are not profitable for the hospital.

As demonstrated above, it is not possible for veterinarians to run a profitable, sustainable pharmacy by selling products that can be purchased elsewhere at lower prices. Retail pharmacies often sell human generics as "loss leaders" to attract customers to the store so they will buy other products. In this way, the drugs represent a marketing expenditure and are not meant to be profitable. Other pharmacies embark on community-pricing initiatives to avoid losing customers to retailers offering discounts. This is one important reason why veterinarians should not compete with pharmacies by selling human generics.

The importance of customer service

It is important for veterinarians not to judge a client's desire to save money as disloyalty to the practice. After all, when a client receives a prescription from his or her physician, he or she may compare prices at different pharmacies, including online and foreign pharmacies.

Clients pay professional fees to the veterinarian for medical advice. As far as they are concerned, the purchase of the medication is just a commodity transaction. It likely has nothing to do with how they feel about the medical care the pet received, and many are shocked to see veterinarians react in a threatened manner when asked if the same or equivalent medication might be available online or at a retailer. Do not be threatened or respond defensively because this would be an overreaction to an honest question and could adversely affect the client's perception of you as a pet health advocate.

Your goals should be to select the most appropriate medication for the patient, to make a reasonable profit on stocking and dispensing appropriate medications and for clients to receive value for pharmaceutical purchases, medical services and counseling. These goals may require changes to the current pharmaceutical pricing models used by veterinary practices, adjustments to professional production compensation for associates, preferential stocking of products labeled for use in particular species, appropriate communication about benefits and risks of all medications dispensed and serving as an advocate for the needs of clients and pets. Additional considerations include the following:

Educate clients about pet insurance to help them afford needed medications

Provide your own Web-based pharmacy if clients find this convenient

Remind clients to administer medications on schedule, especially those that are periodically administered, such as heartworm and flea-control products

When medically prudent, use injectables to improve compliance and convenience

Expect professional compensation for professional services and retail revenue for commodity transactions

Summary

The veterinary pharmacy is at an important cross roads, and veterinarians will ultimately determine whether it remains an important profit center or continues to be eroded by outside competition. Success is predicated on veterinarians acting in their best interest and stocking competitively priced, veterinary-labeled products rather than human generics. New models and approaches need to be considered for the profession.